RBA may have to cut rates again

While the Treasurer naturally prefers to highlight the resilience of the Australian economy, economists are focusing more on its sub-par growth and the possible need for more stimulus from the Reserve Bank.

They also are concerned about the possible impact on the budget’s revenue estimates of the economy’s almost certain failure to meet the budget’s forecast of 3.25 per cent nominal growth for the current financial year. To meet the forecast growth,
Deutsche Bank
’s
Adam Boyton
and
Phil Odonaghoe
point out, nominal gross domestic product would have to grow by more than 4 per cent in the June quarter.

A lower than forecast starting point for nominal GDP in 2013-14 raises questions about the level of tax revenue likely to be raised in the coming financial year. It’s true the economy continues to outshine most of the rest of the developed world, despite the fall in the terms of trade.

But real GDP has been growing at an annualised pace of just 2.4 per cent for half a year now and, if the RBA forecasts are right, won’t do much better than that over the whole of 2013. That growth is not fast enough to stop the unemployment rate from rising, perhaps to more than 6 per cent, and the Reserve Bank may again have to cut short-term interest rates to support growth.

The economy still is in the early stages of its transition from the mining investment boom to more broadly-based growth. At the same time, the federal and state governments are engaged in a program of fiscal consolidation.

Fiscal snapshot

The March quarter national accounts provide a snapshot of the economy between those stepping stones.

Mining investment was showing the early signs of coming off, indicating that the boom already may have passed its peak, while non-mining investment and housing construction had yet to be fully ignited by the RBA’s low interest rates.

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Business investment in new construction, and plant and equipment subtracted from growth in the March quarter. Housing construction made some contribution to growth, but it hardly was the growth engine the economy needs.

Consumer spending, which represents more than half GDP, was quite subdued, growing at an annual rate of only 2 per cent in real terms which is well below its long run average.

At the same time, mining export volumes were picking up. They will grow strongly regardless of what happens to mineral prices, thanks to the massive expansion of mining capacity. But, while the trend acceleration of export volumes is strong, the actual numbers vary from quarter to quarter, and the March quarter’s number was one of the less impressive ones.

It’s too early to say if the economy will need more priming. The RBA’s two percentage-point rate cut over the past 18 months means that household quarterly spending power is now about $3 billion higher than it would have been without the cuts.

Decline offset by falling commodities

But the decline in the exchange rate barely has had time to affect confidence, let alone investment decisions, net exports and economic activity more generally. Some of the exchange rate’s decline has been offset by falling commodity prices, but part of it should provide a useful net boost to activity.

It obviously also takes time for the low interest rates to translate into risky spending decisions like investment in new manufacturing plants and tourist hotels and even building new houses if the potential home owners have been worried about their jobs.

The economic transition is bound to be bumpy, especially when investment decisions are plagued by uncertainties about the global economy, the exchange rate, and the policies that will steer the economy after the September election.